Question:
“Hi Gary: My friend bought a home a year ago. He’s getting ready to refinance it so he can get money to pay off other debts. After he refinances he’s going to sell and get another place. I told him he’d have to pay taxes because he’s had it less than 2 years. But he said he won’t have any capital gains because when he sells he’ll get just enough to pay off the loan. Who’s right?”
Answer:
You are.
Capital gains has nothing to do with “net proceeds” from a sale.
Otherwise everyone would do what your friend is proposing: refinance to the hilt, then sell and net nothing. Voila: no taxes! Sorry, that won’t work.
Here’s the basic formula to determine taxable gain:
Sales price today
– Selling costs
– Improvement costs (remodels, additions, etc)
+ Partial sale (e.g. if you sold off part of your lot)
– Purchase price (when you bought)
– Purchase costs
———————————————
= Taxable profit
As you can see, the loan amount and net proceeds are not part of the equation to determine taxable gain.
Now there could be a whole other set of reasons your friend could avoid paying tax. If he, a co-owner, or an immediate family member has had an unexpected event occur, such as loss of job, job transfer, health problems, etc., he may be able to exclude some or all of his gain. The rules are too lengthy to go into detail here.
As I am NOT a tax professional, please verify the above with your favorite CPA or tax attorney.
